The Percentage of Completion Method Explained

Another disadvantage of this method is that companies use it to manipulate their profits and losses during a period. As a result, accountants often understate or overstate revenue or expense recognized to drive the company’s performance.

If a taxpayer incurs an allocable contract cost after the completion year, the taxpayer must account for that cost using a permissible method of percentage of completion method accounting. For most working taxpayers, accounting for income is as simple as keeping a record of W2 documents they receive from their employer.

GAAP Completed Contract Method

To determine how much revenue to record during a time period, you begin by dividing the expenses you have incurred from the beginning of the period until now by the total estimated expenses for the contract. This gives you the percentage of the work that has been completed during the period. Once you have calculated the percentage of work completed in the period, you then divide that by the total value of the contract to arrive at the amount of revenue you should recognize.

For example, K.K & Sons Construction Company is building a Gas-fired Steam Power Plant, has an estimated eight million dollars ($8,000,000) in project-related costs and the total estimated contract revenue is ten million dollars ($10,000,000). Percentage of completion methodmeans the generally accepted accounting principle under which revenues and expenditures arising under a long-term contract are recognised by reference to the stage of completion of the contract. Percentage of completion methodmeans a system under which payments are made for construction or other work according to the percentage of completion of the work, rather than to the costs incurred. Another essential element is the contractor’s ability to make dependable estimates regarding the contract’s costs and progress. To measure progress towards completion – in other words, the completion factor – under the PCM, the contract can rely on the costs encountered, the efforts expended or the units delivered. This method differs from the completed contract method because it reports revenues and expenses on a period-by-period or work-in-progress bases.

Advantages of the Percentage of Completion Method

While the PoC revenue recognition method can be extremely beneficial for many organizations, it’s not without its limitations. As mentioned, in order for the method to be successful, the company must be able to estimate revenues, costs, and the total length of time of the project. If your business model is prone to wild fluctuations in materials costs, or your projects frequently run well beyond estimations, it may be better to stick with a more definitive revenue recognition method.

Unfortunately, like all matters of construction billing and invoices, there can be complications with the POC. Change orders and slow payments are common factors in the construction industry. These issues can mean your percentages fail to add up, which results in overbilling, underbilling, or other inaccuracies. Cost and revenue estimation for a specific period and percentage of contract completed enabling an accountant to identify the project’s value and income to date. XYZ Ltd. took a contract to build an airport at a contract price of $125 million. The estimated cost for the contract is $100 million within three years. When using the percentage-of-completion method of accounting for long-term contracts, the…

Product Overviews

Reports given during the project cause no changes in the balance sheet, but the income statement carries such reports. In the percentage of completion method, reports are given based on the stage of the completion of the project. Both parties to the contract should be able to fulfill the contractual obligations. The contractee should be able to pay and take complete responsibility for the project once the work is completed and the risk is transferred to them. Often, a long-term contract can be split into multiple smaller units delivered to the customer. The price, delivery schedule, units, etc., of each separate unit, are mentioned in the contract. Accounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared.

For this purpose, an event that occurs after the end of the taxable year must be taken into account if its occurrence was reasonably predictable and its income was subject to reasonable estimation as of the last day of that taxable year. Under the newer guidance, contracts that transfer control over time would use a percentage of completion to determine how much of the performance obligation’s price is earned. Under the five-step model, this requires contractors first to identify the performance obligations in the contract and allocate a transaction price to each one.

Using the cost-to-cost method, the units-of-delivery method, or the efforts expended method, measure the extent of progress toward completion. This means calculating the percentage completed by finding the proportion of cost incurred to date to the estimated total cost. GAAP prefers the unit-delivered https://www.bookstime.com/ method as the way to calculate the completion factor because it’s a direct and easily verified measure. Production contracts can measure completion based on the units produced or units delivered divided by the total units that the contract requires, reports Accounting Tools.